The Manufacturing Odyssey

I spend a lot of time reading about lean manufacturing, looking at what companies are doing – both successfully and not so successfully – and looking at what governments around the world are doing with manufacturing. The unavoidable conclusion I draw from all of this pondering is that lean manufacturing is inevitable – in ten or fifteen years it will be just about impossible to find a manufacturer anywhere on the globe that is not lean. What remains to be seen, however, is how many people will be hurt and how many billions of dollars will be wasted getting from here to there.

The economists – both the die hard free trade advocates and the ones staunchly in favor of government control and protectionism are all dead wrong (good luck getting any of them to realize that). The protectionists are wrong because their whole premise is built on ignoring the concept of value. A country can force people to only buy things manufactured in that country, but if the stuff is not made well or cost effectively, then it turns out to be nothing more than squandering a big chunk of the country’s wealth on waste. The U.S., for example, could pass a raft of restrictive laws and effectively kick Toyota and Honda out of the U.S., making Ford and GM your only car options, but the net result would be for all of us to spend more of our paychecks on cars of lesser value, helping no one but the auto workers, and hurting everyone else.

The free traders are wrong because they are as oblivious to economic reality as their close cousins on Wall Street and in the corporate accounting offices. All of them have a simple minded fixation on labor cost that no amount of pompous, multi-syllabic driveling can make sound intelligent any longer.

Consider the clothing retailer who is stuck at the end of the season with a warehouse crammed with millions of dollars worth of inventory that is out of season, out of style, and the owner of it is out of luck. Where could he have possibly gone wrong? He had the clothes made in some place you have to get to by hacking your way in with a machete. The clothes were made by people willing to work for fifty cents and a handful of rice a day. The free trade economists blessed the whole scheme for its conformance to Adam Smith’s age old theories about having everything made in the country with the lowest cost. His company stock shot up when he told Wall Street that he was going to close the U.S. plant and outsource it all, saving a boatload of money. His accounting department not only blessed the scheme, but were its strongest proponents. He did everything right, only now the only management decision left to make is which chapter of the bankruptcy code to file under.

What the whole bunch failed to take into account was time. From the accountants to the Wall Street analysts, the execs to the economists, the only value of time they understand is the interest rate on money. But the cost of all that dead inventory sitting in the clothing retailers warehouse is a lot more than 4 or 5% interest on what was paid for it. It is more like 90% as he scrambles to find some Dollar Store somewhere to take it off his hands.

I had an interesting talk with Kathleen Fasanella yesterday at Fashion Incubator who knows about such things and, according to her, if a retailer wants to get a batch of clothes made in the U.S. in a big hurry to catch the next fashion wave, that retailer is probably out of luck. The clothing manufacturers in this country are booked solid. They can’t add capacity fast enough to keep up with demand. That makes sense. Seasons and trends come and go. To think that a clothing retailer can ignore that bit of common sense, and go to the market in Columbus, Ohio with a container ship full of product ordered from some Asian apparel maker 8 or 9 months ago and make any money is just plain dumb.

Is their marketing slogan really, "You have to look at last year’s fashion magazine to find it, and you will look just like 75,000 other people in Columbus wearing the same thing because I ordered in bulk, but buy it anyway because it is cheap"? In fact, the marketing campaign really is something like that because the marketing and finance driven companies have long relied on their ability to con people into thinking if they do not look just like everyone else, then they simply are not attractive people. More and more, however, consumer rejection of that sort of manipulation, coupled with a great deal of competition in the message about what to wear to be cool, makes that a tough business sell. Retailers are finding that the only way to win is to find out what customers want and give it to them, rather than play the silly mind game of controlling customer wants.

First the clothing manufacturers shut down their U.S. plants, devastating hundreds of communities and tens of thousands of lives in order to placate Wall Street and comply with Adam Smith’s directives, making everything in what their misguided logic determined to be the ‘lowest cost country’. As they took more and more of a beating having production in bulk on the other side of the world fail to meet the pace of consumer demand, they hauled their globes back out and had production moved closer – to the Caribbean or Mexico or Central America – assuming that paying the outrageous labor rates of almost a dollar an hour to save distance would solve the problem. Only the problem was their business model, and geography only compounded it. Today, a lean clothing manufacturer in the U.S. writes their own ticket. Retailers still beating their heads against the wall agonizing over cost – oblivious to time – are falling by the wayside.

The same is true in consumer electronics which is so dynamic that a nine month life makes a product a superstar. Giving up a fourth of a product’s life to manufacturing and logistics lead times to save labor cost – especially when direct labor is apt to be less than 7-8% of the product cost – is turning out to not be a particularly smart business strategy. So the big accounting driven manufacturers outsourced manufacturing to Asia, then bailed out all together. Now, quietly and mostly below the radar screen of the Wall Street Journal, very lean contract electronic manufacturers in the U.S. are doing a brisk business.

The same process has repeated, is repeating, or will repeat in every manufacturing sector. In the end, manufacturing will inevitably take place close to the market by lean companies. Any other approach is inherently wasteful and cannot compete in the long haul.

This destructive manufacturing odyssey is occurring at various stages over the globe. A manufacturer in a developed country – the U.S., Canada, Germany or japan or the rest – can either become lean or outsource to a cheap labor country and eventually die. Eventually the manufacturing work will come back to the country where the demand is; but it will come back to a lean manufacturer. A manufacturer in a developing country – China, Malaysia, Viet Nam or the rest – will not ride the ‘global batch production on the backs of cheap labor’ horse for long. In the end, they must find a way to produce in a lean manner for their own regional economy.

The upheaval and waste of lives and money as manufacturing everywhere converts to lean has been enormous already, but it is likely to become worse. States and communities that pour millions of tax dollars into incentives to keep or attract ineffective manufacturers are merely pouring money down the drain and delaying the inevitable. It is a shame that so many good people working in manufacturing – first in the U.S., then in Asia, and soon in Central America – have lost their livelihoods and had their lives so disrupted simply because the financial and economic leaders have been unwilling or incapable of pulling themselves up the lean learning curve.

When old Adam Smith wrote about pin factories and the notion that the underlying value of products was based on the labor it took to produce it, the idea that pin technology would change monthly never crossed his mind. Woody Allen once said, It is not what you know that counts. It’s what you think of in time." The corollary in manufacturing is that "it not the labor value you add that counts, it is the labor value you add in time to meet the market". When David Ricardo expounded on ‘Comparative Advantage’ he did not address how buying cloth and wine in Portugal could be good for England if the cloth was outdated and the wine had soured by the time it got to England.

Comments

I think you have unfairly maligned ol’ Adam. I can’t remember anywhere where he prescribes sending manufacturing off to the lowest cost country; his arguments were against Mercantilism, the idea that you must keep all trade internal because money leaving the country is inherently bad and that you can improve the general welfare by using tariffs to protect domestic manufacturers. Spain made it illegal to send gold out of the country, and in so doing became the poorest nation on the continent within a century; other nations have tried to practice autarky and soon found it necessary to establish colonies, sometimes in their neighbors’ countries; and our own steel industry hides behind tariffs that hurt both our own domestic manufacturers (and their employees) who use steel as an input, and their consumers as a result. The policy is not only not beneficial, but is almost certainly harmful to the general welfare, which Smith and his predecessor, David Hume, showed conclusively.

But I do remember several of Smith’s discussions about the higher productivity of workers in wealthy countries and even (gasp) the time cost of changing tools. He may have been the original SMED promoter, though in those much more relaxed times, maybe SHED would have been more appropriate. Furthermore, Smith certainly understood and wrote about improvements in industrial technology, though in that day they moved at a nearly glacial pace. You of all people should be glad that Smith, an academic, apparently liked to go watch manufacturers work in their shops, and that in fact was the source of many of his insights. Sound familiar?

The Labor Theory of Value was abandoned over 100 years ago by everyone except hardcore Marxists, so hanging modern economists on that old mistake of which none of them is guilty is a little unfair. This is a little like calling Newton an idiot because he didn’t account for quanta, and Einstein an idiot because he admired Newton.

Rather than hanging all of this on two economists dead over 150 years ago, why not pin it on the misapplication by modern polemicists and “managers” who abuse them today? As I argued on CafeHayek a week or so ago, comparative advantage (still a brilliant insight) is usually employed as an appeal to authority misdirection from the sleight-of-hand switch to absolute “advantage”, and I further contended that the lower hourly wages are not even an absolute advantage because the key metric is hourly value added (what is technically “productivity”, though you & I agree that official productivity numbers are suspect at best). Ricardo wasn’t wrong: he is wrongly abused, and that is not his fault.

And aged wine isn’t inherently bad ;~) In fact, Kathleen argued right here on your own blog that there is a limit to how far lean principles can be applied back up the supply chain to raw materials. Grapes and yeast grow on their own schedule, not after a customer orders the wine.

Otherwise, I agree with your central point that time must be made a more central consideration. GM is learning (or refusing to learn) this lesson the hard way.

I suppose you are correct in that the economists have expanded their definition of value and cost beyond labor, and it is Wall Street, the business schools and the FASB that have not been able to move forward.

So I guess that just leads me back to the focus of all of my earlier rants.

As far as wine is concerned, I’ll have to accept your input. I rarely make it past the Anheuser-Busch display case to the part of the store where all the expensive stuff can be found.

Bill,
I have to agree that you went too far against ol’ Adam Smith. Seems to me that it’s the accountants, not the economists that have done us wrong. Smith argued that companies should seek the lowest cost producer, wherever and however they might be found. Nothing wrong with that, assuming that you use a relevant and accurate means of measuring cost (time included). My finance for engineers instructor in grad school had an important lesson for us: there’s finance, there’s cash, and there’s accounting. Try not to mistake them for the same thing.

“The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities.”
Adam Smith – The Wealth of Nations, Book 1, Chapter 5, Paragraph 1

Eric says modern economists have recognized the limitations. I haven’t noticed that in the writings of the ardent pro-free tade economists who seem fixated on the notion that we all benefit from having the more labor intensive manufacturing performed in cheap labor countries, but Eric is the man – so I’ll take his word for it. However, nowhere in The Wealth of Nations can I find Adam Smith addressing the time value of a product.

“Labour, therefore, is the real measure of the exchangeable value of all commodities”, Smith says? A person’s abor is worth zip if it goes to produce something that does not reach the market when a buyer wants it.

I think what Smith meant in this context is that a thing is worth the labor it buys, not the labor that went into it. Something that reaches the market too late has little value and therefore doesn’t buy much. The other labor theory of value (LTV), Ricardo’s great mistake and Marx’ gospel, is that a thing is worth the labor that went into its creation. That pretty much went out the window as a result of the Marginal Revolution.

I do think that economists have a blind spot about the value of management theory. Marshall included organizational structure along with capital, labor, and raw materials as an input to production, but didn’t go much further. Only since about 1960 or so did they start looking inside the black box called “The Firm”, thanks to a smart guy by the name of Ronald Coase. I don’t think much thought has gone into determining the advantage that lean accounting has as a factor of production, so I think it’s an area ripe for research.

As to whether we as a society benefit from having labor intensive manufacturing done in developing countries, that’s a subject of substantial debate, spawning “dark matter” theories that get a little too esoteric for me. My feel is that it works, but we don’t understand why or how well as well as we would like to, and when you don’t understand those two things, you don’t know the dynamics or potential. In other words, it could come around to bite us.